Anomalous angle

The idea of large caps catching up with midcaps is silly

Mid cap and small cap stocks have outperformed their large cap counterparts by a huge margin in the past four months. So much so, that some market experts even suggest large caps may catch up. This is because, in many cases, the valuation of mid-cap shares has exceeded that of large caps.

Needless to say, this is an anomaly given the higher risk attached to mid cap and small cap stocks. But using the mid cap rally to justify a rise in large cap stocks makes no sense.

It needs to be understood that driving mid cap stocks requires considerably less money when compared to large caps. All mid caps and small caps put together account for only around 11 per cent of the National Stock Exchange's total market cap.

Before the rally began in mid-May, they accounted for 10 per cent of the total market cap. Despite the high degree of outperformance, these stocks have increased their share in the total market cap by just 1 per cent. To suggest that large caps should follow in their direction is absurd.

It's another thing that foreign institutional flow has been strong in recent weeks, which has sustained the share prices of large caps. However, with high inflation, higher oil prices and the probability of interest rates going up, the only reason share prices are going up is not valuation, but liquidity.

Mid caps, surprisingly, continue to outperform which means their valuation premium is now even higher. This surely is an anomaly, which will be corrected when mid cap prices fall, not when large caps catch up.

Bank takeovers

While all the talk of bank consolidation has focused on mergers and acquisitions, the current spat between the Federal Bank employees and ICICI Bank poses an interesting question. Some Federal Bank shareholders have alleged that ICICI Bank wants to gain control by nominating its own people to the bank board.

ICICI Bank has denied the allegations strongly. Irrespective of the truth or otherwise of these allegations, the Federal Bank stock has moved up smartly in the past month, easily outperforming the Bankex.

But leaving aside this particular case, there is the interesting issue of whether any bank with widely dispersed shareholding can indeed be taken over by another by packing its board with handpicked nominees.

There are, of course, innumerable ways in which a bank may benefit from controlling another "" it could, for instance, be a partner in its lending decisions, using the bank to get around the restrictions in lending to a group or single entity.

It could use the target bank to cross-sell its products, and it will have access to its board decisions, enabling it to shape its own strategy having regard to that of the other bank. It will be recalled that a change in management in Bank of Rajasthan was effected through changes in the board.

To be sure, the restriction limiting voting rights to 10 per cent is effective in shareholders meetings, but it doesn't affect control over day to day management once a boardroom coup establishes that control.

The point is that the RBI, or Sebi for that matter, must realise that merely limiting or monitoring ownership and voting rights is not enough, and the regulator needs to lift the veil to establish whether control has indeed changed hands.

Jindal Vijaynagar Steel's pact with Duferco

Switzerland-based Duferco has signed an agreement with Jindal Vijaynagar Steel Ltd for a bulk deal for sale of pellets for a consideration of approximately Rs 460 crore.

It is understood that these proceeds will be utilised in pre - paying the debt of JVSL to the tune of approximately Rs 400 crore - Rs 450 crore. An immediate benefit from a reduction in the company's debt burden would be a fall in its interest payments which amounted to Rs 409. 28 crore in FY 04. (An emailed questionnaire sent to the company regarding the deal with Duferco and related developments went unanswered.)

Also this block sale of pellets is expected to significantly reduce the company's overheads related to marketing "" for steel companies these have been estimated at 2-3 per cent of sales. The cost savings from these twin moves are expected to result in improved operating profit margins for the company from Q3 FY 05.

The larger point, however, is that, in an environment of uncertainty with regard to steel prices, the company has at least hedged its volume risk.

Secondly, it's essential that Indian steelmaking capacities cater to global demand, rather than a merely local one, because that would enable larger scale, which in turn would drive down costs. Deals such as these help achieve that objective.

As Ashok Sud of Standard Chartered (the bank that structured the deal) pointed out, "The deal confirms repositioning of the Indian steel sector."

With contributions fromMobis Philipose, Janaki Krishnan and Amriteshwar Mathur